Odds of a Bank of Canada “Micro” Rate Cut Diminish Following Rate Decision
A growing chorus of voices suggesting the possibility of a “micro” Bank of Canada rate cut were tempered following a slightly more “hawkish” rate announcement on Wednesday.
Ever since BoC Deputy Governor Paul Beaudry’s suggestion in December that the Bank could take interest rates lower than its current 0.25% policy rate—though not below zero—many started to believe the Bank may deliver a 10- or 15-bps rate cut (smaller than its traditional 25-bps rate movements) to combat floundering economic performance.
But there was no mention of changes to the Bank’s current monetary policy in its latest rate decision. Instead, the BoC reiterated that it will hold rates at the effective lower bound of 0.25% “until economic slack is absorbed” and 2% inflation can be “sustainably achieved.”
Further clarifying its expected timeline, the BoC added, “In our projection, this does not happen until into 2023.”
The Bank added that it will continue its Quantitative Easing program, but it will taper its bond purchases accordingly once the recovery is well underway.
“In the end, we avoided the rate cut that the market had been increasingly pricing in. If there was a time to lower the policy rate, this would have been the meeting to do it given the surge in COVID cases, strong Canadian dollar, ugly December employment report and negative growth outlook to start the year,” economists from National Bank of Canada wrote.
“If, as we expect, COVID case counts decline, nationwide inoculation continues and the economy cautiously reopens again, the Bank will have a much harder time convincing the public that more interest rate accommodation is needed.”
Optimism from the Bank of Canada
Some have called the Bank’s latest rate announcement more hawkish compared to previous statements. Despite forecasting a decline in GDP in the first quarter, the BoC expects 4% growth overall for 2021, followed by 4.8% growth in 2022, an increase from 3.7% in previous forecasts.
“The economic recovery has been interrupted in many countries as new waves of COVID-19 infections force governments to re-impose containment measures,” the Bank said. “However, the arrival of effective vaccines combined with further fiscal and monetary policy support have boosted the medium-term outlook for growth.”
Another factor missing from the Bank’s analysis, according to TD Economics senior economist Sri Thanabalasingam, is the pent-up savings resulting from the lockdowns, which will eventually be released into the economy.
“Households have accumulated around $150 billion (6.4% of GDP) in additional savings over the second and third quarters of 2020 relative to the pre-pandemic period,” Thanabalasingam wrote. “If this money is deployed as the economy opens up, growth could be stronger than the Bank anticipates. If this generates sizeable inflationary pressures, it may push the Bank to move earlier than expected. Time will tell.”
Economic Optimism Raises Odds of Earlier Rate Hikes
Markets seem to agree with an earlier rate move upwards, and are starting to price in the BoC’s first rate hikes as early as late 2022.
For those looking for guidance in terms of fixed vs. variable rate selection, RateSpy.com’s Rob McLister had this to say: “(The) BoC statement does nothing if it doesn’t reinforce one thing. Variable-rate holders will enjoy many more months in the sun, but the least risky path for average homeowners is a 5-year fixed from a fair-penalty lender…one with flexible refinance options,” he wrote.
Indeed, 5-year fixed rates remain at historic lows, guaranteeing rate security through to 2026 for those worried about rate increases with a floating rate. Despite variable rates offering a roughly 30-bps discount vs. comparable fixed rates, that advantage may not last for long.
“(Even) if the BoC begins hiking as planned in 2023, that narrow variable-rate advantage could evaporate in short order,” McLister added.
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